Magazine

Energy Costs Are Draining Asia

September 18, 2005

Tony Fernandes, CEO of AirAsia, Southeast Asia's largest low-cost air carrier, can't believe his luck. As the region's large commercial carriers fall into heavy losses due to rising fuel prices, AirAsia's planes are full and its bottom line robust. That's because Fernandes earlier this year hedged his fuel purchases -- pegging them at a relatively low price when oil was $50 a barrel. In recent weeks, as Hurricane Katrina ravaged the Gulf Coast in the U.S. and oil hit $70 a barrel, Fernandes was in good shape. "It's a crisis for high-cost flag carriers but an opportunity for us to grow our share of the market," he says.

But Kuala Lumpur-based AirAsia is very much the exception. Across Asia, companies are reeling as high oil prices -- as well as shortages in some markets -- make a mess of their balance sheets. And governments are beginning to reduce their growth projections on the assumption that oil prices will remain high. Every $10 rise in a barrel of oil cuts half a point off the growth of the economies of Taiwan and South Korea, Asia's tech leaders. Even mighty China could see growth slow from the current 9% to 7.6% by next year if oil is priced at $70, according to UBS (). Gasoline shortages have been reported in Guangdong province, and the government has forbidden the export of refined petroleum products.

Until recently "economies in Asia were ripping along," says Tim Condon, chief Asia economist for the Netherlands' ING () Bank in Singapore. "This oil shock slows down that rapidly moving train." Asia excluding-Japan's net oil-import bill has ballooned from $65 billion in 2003 to $117 billion in the 12 months to June, 2005, according to Lehman Brothers (), Thailand's net oil-import bill now accounts for nearly 9% of its gross domestic product, while the Philippines spends 5.5% and South Korea 4.2%. "Clearly, high oil prices are not good for any economy in Asia," says Michael Spencer, chief economist for Deutsche Bank Securities Inc. () in Hong Kong, "except maybe Malaysia" -- an oil exporter.

SUBSIDY TROUBLES

Worst hit are governments that subsidize fuel to avoid social unrest, chief among them Indonesia. Gasoline retails for 25 cents a liter in Jakarta -- compared with 80 cents in the U.S. and even more in Europe. Jakarta also subsidizes kerosene used for cooking. Efforts to cut the subsidy have in the past triggered riots. But if they continue at their present level and oil sells for $70 a barrel, the subsidies would cost $13 billion a year, or 6% of the budget. Two weeks ago that prospect sent Indonesia's currency and stock markets plunging; they only recovered after Jakarta promised to find a way to pare back subsidies.

Other nations have already bitten the bullet. Thailand did away with subsidies earlier this year; India has been cutting them regularly over a period of several years. The risk, however, is that the removal of subsidies will create inflation, which will force governments to raise interest rates, which in turn will slow growth. That's what has happened in Thailand. The government of Prime Minister Thaksin Shinawatra raised base interest rates 25 basis points Sept. 7, to 3.25%, making the total increase in the past year 200 basic points. Partly as a result, Thai growth is expected to fall, from 6.1% in 2004 to 3.5% this year.

India, which imports 70% of its oil and still subsidizes much of it, has been protected from the impact on its current account by huge foreign investment in its stock market -- $1 billion a month. But if macro fundamentals such as inflation go awry, and that investment dries up, there would be trouble. "The day the foreigners stop buying equities, then we'll have a problem," says Morgan Stanley India () strategist Ridham Desai. "The cost of capital will go up, growth will slow down, currency will depreciate. It's a virtuous cycle right now that could become a vicious cycle if foreigners leave."

Meanwhile companies across the region are doing what they can to compensate for high energy costs. In Korea, the world's seventh-largest oil consumer, rising oil prices in recent months have dealt an added blow to an energy-deficient economy already suffering from weak consumer spending. Hyundai Motor Co. in Seoul is ready to change the production mix on its assembly lines. "If oil continues to stay high or climbs even higher," says Oles Gadacz, a spokesman for Hyundai, "then we'll see customers start turning to smaller, more fuel-efficient cars." In China, Wei Ding, president of Wanxiang Group, a Hangzhou-based auto-components maker, says high oil prices "are having an impact on us" and, if they last long enough, "will influence the whole world's economic production."

At Holcim Ltd., a Swiss cement maker with extensive operations in Southeast Asia, "we are making huge efforts to replace coal and gas by alternative fuels," says Paul Hugentobler, Bangkok-based executive vice-president for South Asia and Southeast Asia. Holcim now fuels its kilns in part with discarded tires, rubber waste from Nike Inc. () shoe factories, and rice husks. "Net-net," says Hugentobler, "our fuel cost has fallen." If oil prices remain at current levels for an extended period, other companies will need to be equally innovative.